In my experience a flexible budget is a wonderful tool that is frequently used. I'd like to say that all manufacturers use them but I've seen some that don't (and should!). When we compare our static (fixed) budget against our results it can be very misleading to interpret the variances if our production volume (output) is different than the budgeted output. Let's take a small, oversimplified example, to show what I mean. Let's say we had created a budget for this month assuming that we would produce 10 units and have sales totaling $10,000 and net profit of $2,000. The month is over and now we are comparing our actual performance to our budget. We had profit of $4,000. That's awesome! Management is thrilled! But once we start to look at our budget, we realize that our sales was $30,000, again, awesome! We beat our sales target! But we beat our sales target by 3 times our budget and our profit by only twice our budget. If we had a flexible budget showing us our expenses and projections at various levels, we could easily see what we should have made for profits if we had sales of 30 units versus only 10. In my experience some managers simply compare static to actuals and miss the finer details of the variances.

 

1. What are some other dangers we run into by not using flexible budgets?